Half Full or Half Empty?

Stock market gurus have noted mutual fund inflows and outflows for the latest quarter, which show continuing outflows from equity mutual funds and large inflows into bond funds, particularly intermediate bond funds. The conclusion, the gurus say, is that the retail investor will continue to be a contrary indicator, getting out of stocks when the risk is low and potential returns high. These are definitely "glass half full" kind of guys.

The confluence of economic and financial data continues to justify skepticism about equity market performance, which is a "glass half empty" perspective that I share.

We know that the last decade was one of the worst on record for average household income, driven by no real wage growth and fattening of the upper tail of the income distribution curve. Today, the Federal Reserve has reported second quarter household net worth falling by 2.8%, the first drop since the beginning of the financial crisis. Permanent income, which is related to wealth, should theoretically be the driver for future consumption, so this is not encouraging news for the consumer's contributing to the recovery, as was always the case in past cycles.

The University of Michigan Consumer Sentiment Index, which has a decent record as a leading indicator of business cycle turns, fell to 66.8 in early September, the lowest level since August 2009. This is after Cash for Clunkers, Dough for Down Payments, Shovel Ready Infrastructure programs, and other useless Federal programs have failed to effect the popular psyche.

Households continued to pare their debt, but this arithmetic happens because consumer credit card balances and some mortgage debt has been written off. Total household debt fell by $77 billion to $13.5 trillion outstanding at the end of the second quarter. Statistics reported by the Journal show that bank write offs in the second quarter were about $70 billion, almost all of the reported decline in household debt outstanding. We also believe that there is more risk in the pool of outstanding mortgages, not subprime, but prime.

Credit card lenders, if you haven't read your mail, are looking for balance transfers and not for raising lines or lowering rates and fees. So, the consumer can't go back to this well to finance consumption in the future. Bank lending for small business expansion is at a stand still. Bank C&I loans fell 1.9% to $91 trillion. So, it's unreasonable to expect small business creation or expansion to lead the recovery.

On the flip side, nonfinancial corporations now have a cash hoard equal to almost 7% of assets, the highest levels since 1963, according to a Journal chart. Other than share repurchases, there are no large uses of cash being trumpeted, with the exception of some large acquisitions by super-giants like J&J. The point is, to use the language of Keynes, there is a distinct lack of "animal appetites" among the corporate sector capitalists, and so the huge expansion of liquidity and credit has become trapped in corporate cash balances. There is little desire to invest in plant and equipment for expanding operations. With the large layoffs, labor force productivity will rise in the short-term because of the higher capital-to-labor ratio.

For the medium-term, it seems really difficult to find an engine that will pull the U.S. economy out of a low growth cycle. The talk of tax increases offset by spending cuts, proposed by David Stockman, seems like the early supply side theory in a mirror. That theory, as formulated by people like Dr. Mike Evans of Chase Econometrics and the University of Pennsylvania, said that taxes should be reduced with a simultaneous, equal dollar amount reduction in Federal spending. In fact, that theory was never tried. Now, we have Stockman's peculiar, toxic reformulation. There is not much clear thinking about tax and fiscal policy either, which has frozen the markets into a trading pattern.

To finish on a positive note, the Minnesota Twins, once neck in neck with the Chicago White Sox for the division lead, have faced down the big city bad boys with Midwest small ball, and failing a meltdown look like a shoo in for the title. A nice way to end the Summer and lead into Fall.